So, what exactly is the Low-Income Housing Tax Credit?

So, what exactly is the Low-Income Housing Tax Credit?

Jennifer Noonan | Improvement Center Columnist | April 14, 2016

In 1986 the U.S. tax code underwent reform creating many incentives for private homeownership, while at the same time reducing incentives for private investors to own and operate rental properties. Because low-income individuals and families are more likely to rent than to own, the future supply of affordable housing was at risk. In an effort to encourage investment in multi-family rental properties, the Low-Income Housing Tax Credit (LIHTC) program was created. Since then, it's been responsible for the rehabilitation or construction of more than 2 1/2 million homes in the United States. It's the most extensive and longest running affordable housing program the country has ever had. And for good reason.

How does the Low-Income Housing Tax Credit work?

Jennifer Noonan | Improvement Center Columnist | April 14, 2016

The LIHTC is essentially a government subsidy. Each state is allocated funding in the form of tax credits from the IRS on a per capita basis each year. Each state then has an agency that allocates those tax credits to local developers. Developers must apply to the state for those credits, and their development plans must meet certain criteria in order to receive them. If awarded, those tax credits give developers a percentage of what they invest in the housing development back, in the form of credits on their federal taxes. Developers can choose to use those tax credits or syndicate (essentially, sell) them to investors to raise capital.

There are plenty of stipulations, of course. In return for these tax credits, project owners agree to set aside at least 20% of the housing units to be rent restricted and occupied by individuals whose income is at least 50% less than the local area's median gross income. Another 40% need to be rent restricted and occupied by individuals whose income is 60% less than the local area's median income. The maximum rent allowed for rent restricted units is 30% of the maximum eligible income (which is determined to be 60% of the local median income). The project owner is required to maintain that percentage of rent restricted units for an initial 15 year "compliance period," followed by an "extended use period" of at least another 15 years. If they fail to do so, the tax credits may be recaptured by the IRS.

Who can use Low-Income Housing Tax Credits?

Jennifer Noonan | Improvement Center Columnist | April 14, 2016

Developers awarded LIHTC can use them to reduce their taxable income on their federal tax returns. Often though, because they don't have enough taxable income, or because of a non-profit status, they can't use some or all the credits they are awarded. That's where the investors come in.

A private investor, or group of private investors, can enter into a limited partnership with a developer. Most often, the investor(s) keep(s) 99.99% of the tax credits, profits, losses and depreciation from the project. The developer remains the managing partner, and receives the majority of cash flow for maintenance, etc. Every market is different, but historically, these limited partnerships have returned good profits for investors. Investors not interested in becoming limited partners can invest instead in LIHTC funds, which are also attractive.

Financial institutions, like banks, also find LIHTC appealling. When a bank buys tax credits from a developer, it immediately infuses capital into that developer's local project. Those tax credits allow the bank to reduce its taxable income, while also giving it a good return on investment. Also important, investing in LIHTC developments improves a bank's Community Reinvestment Act rating, which it is evaluated on periodically.

Who benefits from Low-Income Housing Tax Credits?

Jennifer Noonan | Improvement Center Columnist | April 14, 2016

Pretty much everyone. Which is why it has remained a vigorous federal program for so long.

Developers benefit, because the LIHTC program helps to generate capital for their projects. Investors benefit by receiving tax shelter and return on their investments. Banks receive the benefit of being able to reduce their taxable income, while also enjoying good investment returns and an improvement of their CRA ratings.

But beyond the direct impact the LIHTC program has on development and investment, there are other beneficiaries. Local businesses benefit when new construction starts, and new jobs are created. Carpenters, architects, landscapers, and more all get new work. Even the corner deli gets busier at lunchtime when construction crews are close by. When local businesses and individuals do well, local tax revenue goes up, and the entire community benefits with more dollars added to the local budget for schools, libraries, and street maintenance. But it doesn't end there. LIHTC are not only awarded for new construction, but also for rehabilitation of old structures. So an abandoned school that's become a community eyesore could be made over into affordable housing for local residents, some of whom may have attended that old, dilapidated school.

When construction is done, and the the investors and developers have moved on to the next project, low-income individuals and families are the final beneficiary. Good, affordable housing options help struggling families, the elderly, the former homeless, and those with special needs, to become independent of government programs, offering them the opportunity to change their future. It's win-win all around.

Investing in LIHTC can be very worthwhile financially. But it's not a simple transaction. Anyone seeking to invest should consult an accountant or tax professional before entering into the process. In the last 30 years, the LIHTC program has been beneficial to investors and communities country-wide, and it provides great hope for the next 30 years.